PBOC shadow banking curbs risk deepening China's junk bond rout

[SHANGHAI] A lifeline for China's local junk bonds is about to get cut, threatening financing for weaker companies already grappling with mounting defaults.

The People's Bank of China will include wealth management products that are held off bank balance sheets in its framework for gauging risk to the financial system starting in the first quarter, a newspaper controlled by the central bank said Monday.

The monitoring may drag on growth of WMPs that banks authorise third-party asset managers to oversee so they can purchase riskier debt with leverage, according to money manager Shanghai Silver Leaf Investment Co.

Chinese lenders, the nation's biggest bond investors, often rely on such arrangements to circumvent risk-control rules. Regulators must walk a fine line in reining in investments made on borrowed money amid a broader rout in Chinese debt, after local note failures jumped four-fold this year.

That's heightened concern that any overreach could lead to panic selling, after steps to trim leverage in equities in 2015 contributed to a US$5 trillion stock drop.

"The yield gap between top-rated and lower-rated bonds may widen in the coming two quarters," said Shanghai Silver Leaf's Shanghai-based chief strategist Chen Qi, who had previously been head of China fixed income research at UBS Group AG. "Those weak companies or industries will have more difficulty in financing."

The outstanding value of wealth management products managed by third-parties was 3.46 trillion yuan (S$719.3 billion) as of Sept 30, accounting for 13 per cent of all such investments, according to research firm PY Standard. About 50 per cent of agricultural banks' WMPs were managed by third parties.

Mr Chen at Silver Leaf, which oversees US$2 billion of assets, said local regulators may strengthen controls on agricultural banks' WMPs managed by third-party asset managers in the coming two quarters.

The central bank's leverage cut has led to bond market turmoil this month. The yield premium on seven-year AA- rated corporate bonds over government notes widened about 40 basis points to 335 basis points, the fastest monthly increase since 2014.

At least 99.8 billion yuan of bond sales have been canceled or postponed in December, compared with 29.7 billion yuan for all of November, according to data compiled by Bloomberg.

"A lot of wealth-management products managed by third parties will mature in the first quarter," said Mr Chen. "There is uncertainty if they can roll over."

BLOOMBERG